Economic Scene; Debt in Buyouts Causing Anxiety

By Leonard Silk

Published: October 28, 1988

THE multibillion-dollar bids to take over RJR Nabisco, Kraft, Pillsbury and other companies have raised anxieties that the heavily debt-financed takeover wave could endanger the solvency of American corporations and the stability of the economy. ''The whole business and financial system is highly leveraged,'' said James J. O'Leary, economic consultant to the United States Trust Company.

How risky is that leveraging for the corporations and their creditors? It is difficult to generalize about the soundness or recklessness of particular mergers or leveraged buyouts. Each depends on who is doing the deal; who will manage the future company and its parts; the quality of the assets; whether the assets were undervalued in the first place, and whether their prices are being bid up to levels that the marketplace will never validate.

There undoubtedly are some deals that make good sense and others that look like manifestations of a buying mania whose ancestry reaches back to Dutch tulip bulbs and Florida real estate. In due course, the market will presumably sort out which deals are which. But the savings-and-loan disaster is only the latest reminder that folly can affect wide classes of institutions and that the marketplace is not always efficient or rational.

The takeover wave also appears to be causing a widespread misallocation of corporate resources, especially of managerial talent, time and energy. Managers these days must be constantly alert to defend against takeovers; and many are spending time planning their own strategies to buy out stockholders and take their companies private. John Robson, dean of the Emory University Business School and a former chairman of Searle, the pharmaceutical concern, worries that management buyouts inherently represent a conflict of interest, but their defenders insist that anything managers do to enhance shareholder wealth is proper, even if managers themselves benefit richly. Indeed, a proposed management buyout may be the best way of putting the corporation ''into play'' and increasing shareholder wealth. After the initial $17 billion proposal for Nabisco, the Wall Street investment partnership of Kohlberg, Kravis, Roberts quickly made a $20.3 billion offer. Other major Wall Street firms swiftly joined the fray, on one side or the other. Who knows what the ultimate price of Nabisco will be - but one can be sure that, in the short run, a tremendous amount of money will be made. Maybe in the long run, too.

Perhaps only a spoilsport can object. Nevertheless, Federal Reserve chairmen are supposed to be spoilsports; in the immortal words of William McChesney Martin, the Fed's job is to take away the punch bowl just when the party starts to get merry. For, however difficult it is to assess the worth of individual leveraged buyouts, there are reasons to worry about the macroeconomic effects of the debt-financed takeover wave.

So this week, with the party getting merry, Alan Greenspan, chairman of the Fed, said in Congressional testimony that, like his predecessor, Paul A. Volcker, he has been monitoring the takeover trend and is concerned about the risks not only to the banks but ''to the economy more broadly.'' He said the leveraged buyouts should be examined ''under a range of economic and financial circumstances.'' What he meant was that debt-equity ratios that looked tolerable when the economy was expanding could be disastrous if the economy were to slide into a deep recession. In this worry Mr. Greenspan has plenty of company, not only among economists but among the bond-rating houses and players in the bond market, who have been marking down corporate bond ratings and prices, wiping out bondholder wealth.

A fiduciary question does arise here: bondholders should be insisting on covenants from corporations to resist the sharp downgrading of their bonds, insisting on protection against undue risk. Henry Kaufman, president of Henry Kaufman & Company, said this week: ''I'm concerned about the accelerated deterioration in the quality of credit. Many companies are not well prepared to withstand another setback.''

This week's Commerce Department report that real gross national product slowed to an annual rate of growth of just 2.2 percent in the third quarter, with inflation at 4.4 percent, raised anxieties that recession may come sooner than most economists have expected. There are other signals of a slowdown, too, like flat industrial production, slipping retail sales, slower job gains, slower exports, slipping gains in profits and rising inventories. A relatively mild and short-lived recession need not create an unbearable debt problem with widespread corporate or banking collapses.

''What would bother me,'' said Steven Axilrod, vice chairman of Nikko Securities and a former high official of the Federal Reserve, ''would be if this takeover wave led to frenetic activity that drove the stock market up just before the recession hit. If animal spirits break loose, it would be most dangerous.'' Unlike the period from 1982 to 1984, he said, corporations are not undervalued now.

So the Fed is trying to calm the ''animal spirits'' in the market for corporate control. The problem for the Fed is that, with the economy already slowing, it does not want to tighten money and credit lest it deepen the danger of recession. And, with inflation at 4.4 percent and the dollar weakening, it does not want to loosen credit lest it risk higher inflation. With fiscal policy on ice, monetary policy could also be frozen in the face of the stagflation dilemma revisited.